Last week the Indian financial sector was rocked by another US$ 2 billion scam in the Punjab National Bank (PNB). According to latest reports the total scam amount can go up to US$ 3 billion. The main perpetrators of this scam are the famous jeweler Nirav Modi and his uncle Mehul Choksi, owner of another famous jewelry brand Gitanjali Gems Ltd.
Media is terming this scam as the biggest in the banking history of India. But is it? In all the noise about this scam everyone is forgetting the 800 pound gorilla in the room i.e., the fact of the matter is, the biggest scam in the banking history not only of India but world are the fraudulent financial institutions of fractional reserve banking, that enables such frauds and scams, and central bank which shields banks from the dangers of fractional reserve banking. Following brief analysis will throw more light on this issue.
Originally banks were a place where people can deposit their property for safe keeping. They functioned as ware houses. One can deposit his property, including money in the form of gold/silver coins, rice, wheat, oil or anything else, for a fee that banks will charge as a price of keeping your property safe. As banking evolved some clever and unscrupulous bankers figured out that apart from charging fees to their depositors they can make even more money by lending depositors’ property (money) to borrowers at interest for a time when those depositors are not coming back to withdraw their property. This is the beginning of the practice of fractional reserve banking. Instead of keeping 100% property of its owners in their reserve, ware house banks started lending them to third party borrowers keeping with them only fraction of depositors’ property. From the legal perspective this was embezzlement and a moral fraud. This practice worked well as long as borrowers returned loaned money on time before the depositors came to withdraw their property. When borrowers defaulted on their loans i.e., they failed to return borrowed money, banks went bankrupt.
Not only this, with the advent of paper money standard bankers found out that they do not have to rely on depositors’ money alone for their fraudulent lending activities, but they can simply create paper money out of thin air and start lending it at interest making huge profit (sic). Issuing too much of this paper credit again was a risky practice as defaulting borrowers sent banks to their demise in the form of bankruptcy and closure. To avoid this problem bankers and governments, who were the primary borrower beneficiaries of bank loans, came together and created a central bank for themselves. The function of the central bank was to protect fraudulent banks from bankruptcy and insolvency by bailing them out when they got into trouble.
And these two institutions of inherently fraudulent fractional reserve banks, both commercial and state run, and state owned central banks are still with us today. They are the root cause behind all the past and present frauds like Nirav Modi PNB scam or Vijay Mallaya scam etc., that we are seeing taking place in India and elsewhere in the world.
In the aftermath of this PNB scam most people are demanding tougher regulation from RBI and strong internal vigilance by the auditors and banks. But as we saw above, the fact of the matter is that the problem here is not of not having strong RBI regulation or not having strong internal vigilance and audit in commercial banks. The problem is the inherent fraudulent nature of banks and central banks themselves. When fraudulent banks and central bank wolves are guarding depositor hen house then how can one expect hens to be safe?
Instead of fractional reserve banking and central bank, if we have free market banking system with 100% reserve banking standard then such scams can hardly take place. When banks will compete with each other for profits then they will become their own regulators. Each bank will keep an eye on other bank because one bank’s fraudulent practice can put all other banks into trouble, and there will be no central bank to bail them out. Suppose bank A fraudulently gives paper credit loan of US$ 500 million to Mr. Jayendra Jaitley and he spends this money in the market buying something. He pays this money to Mr. Rahul Modi by issuing a check. Mr. Rahul deposits this check in his Bank B. Bank B now goes to the clearing house with a claim on bank A. Bank A will not be able to pay this big amount and will be caught cheating. In absence of a central bank, bank A will have to declare insolvency and its assets will be sold to pay bank B and it will go out of business.
So we have to understand that the real problem is not Nirav Modi or Vijay Mallaya. The real problem is this fraudulent fractional reserve banking and central bank system. Coupled with paper money standard, which is another fraud, these two institutions create all financial frauds that we see today. Unless and until fractional reserve banking is outlawed and central bank RBI is dismantled, such frauds will continue to take place.